The tax reform bill signed at the end of last year brought significant changes for many businesses and individuals, including an overall cut in tax rates. Those in the hospitality industry are generally optimistic about the changes, expecting both an increase in consumer spending and the ability to invest in people, technology, development and other improvements in their businesses because of anticipated lower tax liability. Specific provisions in the tax law affect the hospitality industry more than others. To help our hospitality clients, prospects and others understand these provisions, Smith Schafer has provided a summary of the applicable changes below.
- Pass-Through Entity Taxation – About 90% of U.S. businesses are pass-through entities, such as LLCs, S-corporations and partnerships. Owners of pass-through entities used to pay tax on company earnings based on their personal tax rates – up to a rate of 39.6%. Now qualifying pass-through entities will enjoy a 20% deduction on pass-through income for tax years beginning after 12/31/17 and expiring in 2025 (with potential caps for some). This could encourage business owners to reinvest capital to expand their businesses, hire new employees and increase wages and other benefits.
- Expanded Section 179 Expensing – The previous law provided that businesses could deduct up to $500,000 of the cost of qualifying property placed in service during a given tax year. That deduction limit is increased to $1M starting in 2018. In addition, a business owner may purchase up to $2.5M in business property that qualifies for the Section 179 deduction each year before the benefit is phased out (up from $2M), and limits will be indexed for inflation starting in 2019. The definition of eligible property was expanded to include certain depreciable tangible personal property used predominantly to furnish lodging, and “qualifying expenses” was also expanded to include roofs, HVAC and fire alarm and security systems for non-residential property. This expansion was intended to encourage improvements of property and implies larger depreciation deductions for companies that are able to use Section 179 and bonus depreciation.
- Immediate 100% Expensing – Companies will now be able to fully expense certain capital expenditures instead of depreciating over a several year period, including acquisitions of used property, starting with business assets placed in service after September 27, 2017. There is no limit to the amount that can be expensed, but the percentage of allowable expensing will be phased out at a rate of 20% per year from 2023 (80%) to 2026 (20%). This immediate tax benefit is likely to encourage more capital spending, potentially enabling more remodels for restaurateurs, hoteliers and others in the industry.
- Entertainment Deduction Repealed – Under previous rules, companies could deduct 50% for a variety of expenses, such as client meals, event tickets, charitable event tickets and membership fees. The new law effective for amounts paid or incurred after 12/31/17 removes all deductions for entertainment, amusement and recreation, and for membership dues at any club organized for business, pleasure, recreation or another social purpose. This applies even for expenses directly related to the active conduct of a taxpayer’s trade or business. This will impact the hospitality industry directly in many ways, including venues that host conferences, conventions and trade shows.
- Consolidated Real Property Categories – The new law eliminates the separate categories of qualified leasehold improvement property, qualified restaurant property and retail improvement property and consolidates into one category: qualified improvement property (QIP). This has important consequences to real property placed in service after 12/31/2017 and whether 100% bonus depreciation applies.
- Limited Business Interest Expense Deduction – The deduction for net interest expenses incurred by a business will now be limited to 30% of its adjusted taxable income – or earnings before interest, taxes, depreciation and amortization. Businesses with average annual gross receipts of $25 million or less are exempt from the limit. This new rule will generally impact highly indebted companies the most.
- Excess Business Loss – For tax years beginning after 12/31/17 and before 2026, excess business loss of a taxpayer other than a C corporation is limited. Net business loss of $250,000 (or $500,000 in the case of a joint return) will not be deductible in the current year. However, an excess business loss is treated as part of the taxpayer’s net operating loss and can be carried forward to subsequent years.
The tax reform bill will impact the hospitality industry in several ways, many of which are positive, including projected higher spending on travel and leisure activities due to a lower corporate tax rate, lower rate for pass-through entities and expanded expensing rules. Yet some changes may have unforeseen consequences. If you have questions about these changes or tax planning strategies in light of the reform, or need assistance with an audit, tax or accounting issue, Smith Schafer can help. For additional information, click here to contact us. We look forward to speaking with you soon.